October 11, 2022 - 2:15pm
Yesterday gilt markets sold off sharply. No doubt this was a headache for both the government and the Bank of England (BoE), who thought they had got the selloff under control at the start of the month. Yet 30-year gilt yields have now surpassed 4.5% once more and are rapidly climbing back up to past 5% — where they stood prior to the BoE intervention earlier in the month.
Gilts are the markets that the British government taps to finance its borrowing. The interest rate on this borrowing is set jointly by the financial markets themselves and the BoE which provides guidance. Typically, the BoE and the markets work together to set rates, but right now they are working at cross purposes. This shows a disconnect between how the markets perceive the realities of British government finances versus what the BoE wants these realities to be.
The sell-off undoubtedly shows that financial markets are still concerned about the government’s spending plans, despite the Chancellor promising to publish forecasts of the plan earlier than previously stated. But there are far deeper dynamics at work here that, still, no one wants to discuss.
At the beginning of September, long before the much-maligned mini-budget, Deutsche Bank analyst Shreyas Gopal published a note on the British election. Gopal pointed out that the huge increase in energy prices triggered by the sanctions and counter-sanctions on Russia would lead to a blow-out in the British trade account with the rest of the world, estimating that it would rise to 10% of GDP. Given that Britain relies on the City of London’s capacity to attract capital flows in order to run trade deficits, the analyst claimed that 10% of GDP would be a bridge too far for markets.
It is these underlying forces that make the action in the gilts market so ominous. If the selloffs were simply domestic pension funds shedding their long-term government debt, the BoE could step in and provide the liquidity needed to allow the funds an orderly exit. But if the selloffs indicate foreign capital fleeing the British financial system, then we could be facing down the currency crisis that Gopal and others predicted.
Since then, the situation has only gotten more volatile. The apparent sabotage of the Nord Stream gas pipelines in late-September made it appear that even if Europe wanted to remove the sanctions on Russia in exchange for piped gas, they no longer had the option. Since then, Russia has stated that Nord Stream 2 was only partially damaged and that if Europe removes the sanctions, Russia can attempt to pipe gas through it.
Moves in the market for sterling suggest that this could be the case. The day before the mini-budget was announced, sterling stood at £1.13 against the US dollar. On the day of the mini-budget it fell to £1.08 — an enormous 4.5% decline in a single day. Since then, sterling has bounced around and today sits around £1.10.
While it is currently difficult to prove, the firming up of sterling suggests that the BoE is likely undertaking another intervention behind the scenes: namely, selling down its foreign currency reserves. This would be a much more important intervention than the gilt purchases because the BoE only has so many foreign reserves to sell down. If it runs out of ammunition and international capital continues to flee, sterling could collapse.
As of September, the BoE had around $78bn in net foreign reserves. That is enough to fund the current trade account ($33.8bn) for around six months. But if the trade account blows to 10% of GDP as Deutsche Bank estimates claim, then BoE’s reserves will only be able to fund this for less than two months.
Properly read, today’s statement by the IMF confirms this analysis. While the IMF did criticise the British Chancellor’s budget, the focus was on its impact on income inequality and how the cost-of-living crisis would hit working people. Meanwhile, the body’s statement focused much more firmly on the trouble facing the world economy due to the impact of the war in Ukraine. The IMF knows that Britain’s problems are primarily caused by the impact of the war and sanctions; the dodgy budget is just the icing on the cake.
It is imperative that policymakers in Britain start to understand that the serious economic crisis that this country faces is a direct consequence of the sanctions policies imposed on Russia after it invaded Ukraine. These sanctions have had a limited effect on Russia, and a much worse effect on us. Through rising energy costs — which hurts the British trade account — they risk permanently lowering living standards in this country. It is only when we start addressing these issues that we might be able to find a way out of this crisis.
Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics
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SubscribeYes and no. Yes, coming to some sort of detente with Russia and being allowed to purchase BTU’s with Euros/GBP is probably Europe/UK’s only conceivable path towards currency survival at this point. The alternative is financial collapse as foreign reserves are sold down in what is essentially a finite “energy swap line”. And there’s the rub. If the UK and Europe were serious about the “energy war”, they would have never dug themselves into the green energy hole in the first place. And for that, the entire citizenry of these countries shoulders a great deal of blame.
They never gad a chance to rebel against this absurd poicy.
They could have done but didn’t
They did, but the Police usually stepped in to save the Green glue nut jobs.
Canning Town tube station showed what us plebs think about it. Recently in London the offshoot of Extinction Rebellion also got some short shrift. The problem is that until Truss/Kwarteng lifted the lid on the real mess that the global economy of QE/0 interest rates has produced, we’d still didn’t know how bad the fall is going to be.
I tried to comment against this war – but got deleted – the agenda is pro war, it will not be contradicted lightly.
I will just give you the doom warring from Gammon,
‘Bank Of England Hints At Another Repo Market Collapse’
https://www.youtube.com/watch?v=P4dTD_x-_mo
and avoid talking of the war – although it brings as much doom to us as any war has… 2024 and you can look back and be amazed, like say we did in 2004….
Most people on this medium think that Repo is a make of lawnmower ..
What do you suggest the response should be to the invasion of Ukraine?
As I have said before, and supporting this excellent and incisive piece, it baffles me as to why, as mentioned above, UK Government does not take the blindingly obvious, simple, easy and neo ” instant” solution to every single woe in the above piece: BECOME A TAX HAVEN!! There are trillions of every currency on the planet looking for safe, secure ‘ homes’ backed by a proved and trusted legal system. ” Press the button” and bring them, people, company domicile, revenue, capital, spend, investment… and yes… massive gilt purchase/ investment.
Who, frankly, cares whether the money comes from Russia, Myannmar, Ukraine, China or anywhere else? the key is to give those bringing the inflow banking and investment confidentiality.
…. Or do the whining ” oooh money laundering” faux moralists have the veto?
Pilkington has been banging a similar drum here and in the pages of The Critic for some time – I can’t work out whether he is getting something from the Russians for pushing this line, or if he is just a useful idiot. While the underlying economic problems he identifies are real, they are a long-term product of falling UK productivity since the financial crisis, and a short-term product of massive borrowing and economic disruption caused by Covid and associated lockdowns. The sanctions on Russia don’t help, but they have minor effects by comparison – and in any case there are compelling political reasons why they must continue until Russia loses the war in Ukraine (as it is currently doing – I wonder why Pilkington doesn’t choose to mention this). The sanctions certainly are having serious effects in Russia, both crippling its short-term ability to wage war, and destroying long-term prospects for economic recovery, as this report (by a rather better-informed group of economists) makes clear.
Alex, You’re wrong. The sanctions revealed to the market that Russia was the marginal commodity producer for many of the World’s basic commodity staples – oil, nat gas, nitrates, etc…
And the inflation shock the World is going through can be traced back to the severing of Russian raw commodity inputs to the European and World economic system. You look like a well read kind of guy, you must have seen the Credit Swiss graph showing how the German- Euro economy takes about 240 billion of Russian Nat gas and leverages it into 14 trillion of economic activity. WTF do you think is going to happen if this is cut, permanently. How quickly can energy substitutes be provided and at what cost?
But no, we’re all Russia agents. Well, at least we’re not Armageddon agents.
And it’s the cost that means everything. All this talk about storage and sanctions is missing the forest for the trees. Central bake interventions prove that a serious and deadly currency crisis is brewing much closer at hand than anyone should be comfortable with. The fact that the comment above mentioned nothing about currencies or trade deficits shows me that we’re not even close to getting this discussed properly in mainstream channels for citizens to make informed decisions politically.
Russian exports of natural gas to Europe amounted to 5% of global output – certainly the severing of that supply has been a shock which contributes to inflation, but prices were already rising before Russia invaded Ukraine, and they have already fallen from their peak, and will fall further as production elsewhere increases to meet demand. Meanwhile the Russians have at a stroke lost their most important energy export market for both oil and gas. This will be true even if the sanctions are lifted – after all, who would trust them as suppliers again? The infrastructure does not exist to export an equivalent amount to Asia and the Russians have neither the resources nor the technology to build it themselves. The claim made by Pilkington that the sanctions have not seriously affected the Russian economy is simply false, and you have to ask why he is making it.
The underlying cause of global inflation is demand for goods outstripping supply post pandemic, compounded by ongoing disruption to supply chains in China (far more important to the global economy than Russia) as a result of their ongoing crazy lockdown policies. Sanctions on Russia come in third place after this at best. If the turmoil on the British market were really all about sanctions, how does one explain the fact that German borrowing costs are currently half those of the UK, despite the fact that they are far more directly affected by the severing of Russian gas supplies? Or indeed the timing, so airily dismissed by Pilkington above? As Wolfgang Munchau, another rather better-informed economist has observed, the UK is a sort of canary in the coal mine here – it was indeed the badly bungled ‘fiscal event’ which triggered the crisis, but it is indicative of the fact that most developed European economies are reaching the limits of what the bond markets are prepared to tolerate. The Covid-era illusion that you could just carry on borrowing at low interest rates forever has been exploded. I suspect Pilkington understands all these other factors – so the question remains, why does he keep banging on about the sanctions on Russia as the root cause?
“The underlying cause of global inflation is demand for goods outstripping supply post pandemic, compounded by ongoing disruption to supply chains in China”
Are you really saying it had nothing to do with printing huge amounts of money?
That too! But it isn’t primarily because of the sanctions on Russia, as Pilkington is arguing.
because the 5% globally translates to considerably more in Germany, the economic power house of the EU. The EU is heading for the rocks and its Engine Room is failing. It only takes one default and the QE world of dominoes starts to tumble. The irony is that all the people who were ignored when they warned of what would happen when the can-kicking had to stop, all thought lockdown inflation would do it. It turns out Net Zero insanity got there first. It wasn’t just the failing windmills, but the Golden Child of renewables, hydro also failed which led the UK bankruptcies then Putin thinking “Now is my chance, they need gas, I have it!”
One thing, IF the Nordstream 2 isn’t destroyed, then it is likely the US didn’t do it, as I’m sure their military aren’t that incompetent – though I suppose they might be, as they didn’t appear to spot whoever did it under their very noses!
It’s funny because as far as I see it the trust issue is on the other foot. It’s the Russians who cannot trust the collective West. After all it was the West that stopped taking gas not the Russians that stopped shipping.
The Pandemic Fiscal Debt Load simply demonstrates how unaffordable the sanction strategy is.
I agree with you in one sense, outside of the Balkan nations, the die is cast, Russian fossil fuels will not ship directly to Europe for the foreseeable future and will be reoriented to the Global South and far East. As Europe is heavily invested in Green power generation, perhaps this is not as bad for Moscow long term as one may think at first glance.
I still submit that Russia is the Global Swing Producer for many international commodities and until the War is ended these markets will remain inflationary.
Yep, read this in expectation of the presented solution being to withdraw sanctions and bingo there it was. Yawnsville.
You have to admire his persistence, even if most of what he writes is tripe. There doesn’t seem to be a single subject he can’t spin back towards letting Russia off the hook for butchering civilians in Ukraine.
It must have just been a coincidence the markets got scared the day after the Chancellors shambolic mini budget, rather than 7 months ago when sanctions actually came into effect
Billy, your amazingly pro-war stance is also persistence beyond any reason or understanding. The West getting involved in this regional Eurasian conflict was about as useful as France and UK declaring war on Germany after Arch Duke Ferdinand was assassinated in Sarajevo. It should have been none of our business. NOT our National Interests. But the war-mongering Neo-Cons just love their wars – just got to get the cordite in the morning smell with their coffee and muffin.
This adventure in Ukraine by Biden and his mini-me Boris (and 100% backed by Truss!) is the reason British pensions are dead men walking. Why utility bills will bankrupt the nation, why all the West is entering super recession.
You war-mongers wanted WWIII, well you bought your self one. Enjoy it – because all who are not full of desire for war will suffer vastly!
France was invaded by Germany, they didn’t declare war because of the assassination. But you don’t seem to mind invasions too much, apparently.
So where where we when Armenia/Azerbaijan were fighting? This is potentially Balkans Mk 2. Two corrupt oligarchies, former Soviet republics fighting over Soviet imposed borders in a post Soviet world. IF only Biden Hunters hard drive secrets had been published we might discover if WW3 is about to be unleashed to save his pocket book. We had no dog in this fight, Boris tried to save his skin on the back of it.
Billy, What to you think Kiv has been doing since 2014? Butcher indeed.
Indeed Ian. My sentiments exactly – every time I see Pilkington is the author, I brace myself for another bout of pro-Russian economic moralising from Vlad’s man in Europe.
I suppose the fact he is right that is the main reason it annoys.
It would possibly save the EU, but as it stands the EU is in dire straights because if it isn’t the lack of gas & the closing down of Germany’s economy that kills them, then the bond crises that mean Italy can’t cope with much more than a few % rise in interest rates while the East suffers 20%+ inflation may do.
”I can’t work out whether he is getting something from the Russians for pushing this line, or if he is just a useful idiot.”
This is exactly what I wonder of all the pro war posts – as expanding and joining into this war is so absolutely the worst self inflicted disaster the West has gotten into in decades – yet so many here beat the war drums as if this was a good and patriotic thing, instead of a disastrous thing for the entire world, which it is. Biden and Boris did great evil by dumping $80 Billion of gas (and $Trillions in collateral damage) on this regional conflict, making it WWIII in essence.
During the Covid pandemic every Western leader repeated the “Build back Better” strap line which was seen everywhere. As I mentioned frequently at the time to many people before you build back anything you have to take down, demolish the existing. Could they have meant the existing global financial system or even the dollar as the reserve currency especially considering the move towards CBDCs by every central bank. A solution first requires a problem.
This is the all the Cost-of-Lockdown Crisis.
Actually it isn’t – though I agree it would look very, very similar. All the authors I read who were marginalised by the MSM for pointing out that QE/0 interest rates was explosive if ever a black swan inflation event arrived pointed to lockdown as that black swan. Net Zero was simply an insanity and a black swan just over the horizon. Then suddenly summer 2021 we found the Net Zero black swan in our midst, though it was only come autumn that most people realised it when gas prices went stellar & UK gas resellers started going bust. Putin saw that & took his chance which simply ensured it wasn’t going to be the prelude, but this was going to be the real thing. Lockdown inflation is also coming, but Net Zero started it all & Putin took his chance. Now the world is changed, and not for the better, but as you point out, it was going to do so thanks to lockdown meeting QE/-ve interest rates anyway. Net Zero just ensured the world split into two & risks WW3.
The MSM have missed the main reason for the gilt market turbulence; pension funds have been taking highly risky bets on highly risky LDIs. The rise in interest rates has caught pensions fund managers and the BoE/Regulators out. They should have been watching this carefully: Here is an excellent write-up by an academic: https://johnhcochrane.blogspot.com/2022/09/a-familiar-finance-fable-in-uk-bonds.html
and here is one by a practitioner: https://www.nnip.com/en-INT/professional/insights/articles/leverage-in-ldi-a-wonderful-servant-a-terrible-master
The latter blog post dated 2019 points out exactly what could happen and now unfortunately has. No one including the BBC has even mentioned this angle.